With persistently low interest rates and new accounting standards that will add to the weight of their long-term commitments, insurers see the arrival of unprecedented ultra-long bonds as a breath of fresh air. However, the size of the bond issue is minimal compared to insurers’ actual requirements.Finance Minister Joe Oliver continued the game plan for managing public debt that he outlined in his February budget: in late April the federal government issued $1.5 billion of 50-year bonds with a yield of 2.96%. They mature on Dec. 1, 2064. By taking this step, the government is trying to reduce refinancing risk and maintain its good credit rating.
The offering was snapped up quickly, and key stakeholders are already clamoring for more. “The Canadian life and health insurance industry welcomes this positive initiative,” commented Stephen Frank, vice president of Policy Development and Health at the Canadian Life and Health Insurance Association of Canada (CLHIA), in an interview with The Insurance and Investment Journal. “We hope this marks the start of the development of a robust ultra-long term bond market in Canada.”
Les Dandridge, the director of communications and public affairs at the Canadian Institute of Actuaries (CIA), said that the CIA also looks favourably on the new issue. The Institute asked one of its members to give an interview to The Insurance and Investment Journal on behalf of his company, namely Hrvoje Lakota, the chief strategist, dynamic solutions for risk reduction at Mercer in Toronto.
Lakota was tempered in his enthusiasm. He does not believe that a new bond issue will transform the industry. “It is an additional tool in the arsenal, but a $1.5 billion issue is far from solving the problem,” he comments. “Total liabilities of Canadian defined benefits pension plans in the private and public sectors exceed $1 trillion. As such, although this bond issue will not change the industry, it does add to what is available.”
He does hope to see other debt issues. “It would be nice to see other issuers, including provinces and corporations, start issuing longer term debt,” he says.
Lakota emphasized how useful this new tool can be for risk management. While it would rarely appeal to an individual investor because of its low return, he points out that this kind of bond gives insurers and pension funds a way to manage interest rate risk. “A lot depends on what risk you’re concerned about. One of the risks that pension plans are exposed to is that changes in market interest rates can significantly impact their financial position. In general, a rise in interest rates reduces pension plan liabilities. Conversely, a reduction in interest rates increases liabilities,” he explains.
“Bonds tend to behave in the same way as liabilities and hence can be used to hedge a pension plan’s interest rate risk,” continued Lakota. “As such, although for individual investors 50-year bonds might be risky, pension plans can use them to hedge some of their really long dated obligations. Similarly, if you are an insurance company dealing with permanent life policies or life annuities, you also need these really long duration bonds to hedge your long dated liabilities.”
The ultra-long bond issue has certainly given insurers another way to address the weaknesses highlighted by the International Monetary Fund in its assessment of the Canadian financial sector published in March (See article in the April 2014 issue of The Insurance and Investment Journal). The IMF noted that Canada’s bonds were limited to a maximum duration of 30 years, which is now no longer the case.